Session 8: Budgeting Flashcards
What is a Budget?
A budget is an estimation of revenue and expenses over a specified future period of time and is usually compiled and re-evaluated on a periodic basis. Budgets can be made for a person, a group of people, a business, a government, or just about anything else that makes and spends money.
• A budget is the quantitative or financial expression of an organization’s plan
– it should incorporate, or be predicated, on a
business/strategic plan
– it should provide action plans for achieving
an organization’s objectives
• Budgets should include both financial and non-financial aspects of the plan (e.g. sales budget in both revenue [€] and units).
What are the six primary functions of a budget?
(1) Aid the planning of actual operations
(2) Coordinate the activities of the organisation
(3) Communicate plans to various responsibility centre managers
(4) Motivate managers to achieve budget goals
(5) Control activities
(6) Evaluate performance (of managers)
What are the typical steps in a budgeting process?
- Communicate budget assumptions, parameters and process e.g. time period: reforecasts (<1 yr), budget (1 yr), Long Term Plan (3-5 years), incremental versus zero-based budgeting
- Determine key limiting factor(s) e.g. sales
- Initial budget submissions
- Accumulation of departmental and divisional budgets
- Review, coordination and negotiation with Budget Committee
- Board approval of overall budget e.g. P&L, Cashflow and Balance Sheet
- Later: Reporting of actuals versus budget
What is ‘Beyond Budgeting’?
Beyond budgeting is the principle whereby companies need to move beyond budgeting because of the inherent flaws in budgeting, especially when used to set contracts. It proposes that a range of techniques, such as rolling forecasts and market-related targets, can take the place of traditional budgeting.
Why are Automated Data Processing and Version
Control Critical?
Without a distributed budget model, with actuals reporting integrated, using standardised reports (rather
than numerous ad-hoc spreadsheets), things get lost, communication breaks down, no one held accountable.
What are the issues with budget-based compensation?
- Managers have incentive to pad the budget (e.g. lower sales forecast and increase cost forecast, making budget targets easier to achieve)
- Managers may be incentivised to shift income from one period to another
- Alternatively, a manager may also promote an overly optimistic budget, if you are rewarded for ‘underusing’ resources
List some of the primary criticisms of budgeting.
High costs, time consuming Gaming, opportunism Undervalues role of people Cost control > Customer value creation Constraint on innovation Cost maintenance > Cost innovation Rigid, inflexible Limit value for the budget users themselves
CFOs report lack of: ownership/accountability,
cooperation/participation, understanding/compliance and ‘padding’
Some dysfunctional budget behaviours?
(1) Negotiating minor objectives with major bonuses
(2) Prioritising achievement of objectives, at all costs
(3) Customer satisfaction becomes less important than sales objectives
(4) Neither information nor resource sharing w. other teams
(5) Requesting more resource than necessary
(6) Always spending all budgeted items, regardless of need
(7) Developing strong abilities to explain negative variances
(8) Not reporting bad news
(9) Always achieve objectives, but never over-achieve objectives.
(10) Never take a risk. Just don’t do it.
How are budgets used in terms of financial management?
For:
- Planning (enhancing communication and coordination) and
- Control (a basis for evaluating performance)
What are the three possible reasons for significant deviations from planned performance?
(1) It is possible that the plan or budget was poorly conceived.
(2) It is possible that although the budget was carefully developed, conditions have changed.
(3) It is possible that managers have done a particularly good or poor job managing operations.
What is the budget committee?
Responsible for approval of various budgets, typically consists of senior managers, including President/CEO, CFO, VP Ops and the Controller.
Should divisions be consulted when setting their budget?
Depends on whether the company uses a bottom up or top down model. Most managers believe bottom up is the more successful model.
How long should the budget time period be?
Most are a year, though some long-run budgets are 3-5 years. Increasingly, there is a call for shorter budgets to increase their validity (monthly or quarterly).
What is zero-based budgeting?
Starting from scratch each year, rather than passing through last year’s data. Not widely practiced in business, but used a great deal in public sector settings.
What is a master budget?
Comprehensive planning document that incorporates all individual budgets (sales, production, direct materials, direct labour, manufacturing O/H, selling and admin, capital acquisitions, cash receipts and disbursements, budgets income statement and budgeted balance sheet).
How is the production budget set?
Using data from the sales budget, apply the formula
Finished Units to be Produced=
Expected Sales in Units + Desired Ending Inventory of Finished Units - Beginning Inventory of Finished Units
How is the direct material purchases budget set?
Using data from the production budget, apply the formula
Required purchases of direct materials =
Amount required for production + Desired inventory of direct materials - Beginning inventory of direct materials
How is the direct labour budget set?
Direct labour cost is calculated by multiplying the number of units produced each quart by the labour hours per unit and rate per hour.
How is the manufacturing O/H budget set?
Variable and Fixed Costs are separated.
Cost per unit of production of each variable cost item x quantity produced each quarter
Fixed costs are identical each quarter, except for depreciation, or if any planned acquisitions.
How is the Selling and Admin Expense budget set?
Depends on the industry, but often just a fixed cost with no depreciation.
What is the inherent conflict when budgets are used both for planning and control?
The conflict is that there is no perfect way to balance these two items, as there are different goals in mind. The conflict may result in managers (1) padding the budget, (2) shifting income between periods to increase their compensation.
